Global financial crisis points to bankruptcy of policymakers
ANALYSIS:A return to the spirit of Bretton Woods is not only desirable but also essential
THE MOUNT Washington Hotel on the outskirts of Bretton Woods in the White Mountains region of New Hampshire has a storied history. Built as a resort for the New England elite, the sprawling estate hosted the 1944 conference that led to the creation of the primary institutions of global economic order, the International Monetary Fund and the World Bank.
At the weekend just gone, leading policymakers and academics returned to Mount Washington. The timing as well as the location was deeply symbolic. The aim was to ascertain whether the international order remained fit for purpose ahead of the annual spring meetings of the IMF.
Following the catastrophic losses associated with the global financial crisis, do policymakers have either the vision or the tools to manage the politics of austerity? The unambiguous answer was no.
There can be no doubting the ambition or the pulling power of the host organisation, the Institute for New Economic Thinking (Inet), which was funded by the financier George Soros. For Soros himself, who has made his fortune from arbitraging political failure, the system of oversight is not only dysfunctional. The proposed solution of “bailing out the banks and bailing in the taxpayer” is in the longer-term, “unworkable”. It “casts in stone a two-step Europe” and creates societal tension.
The continued failure of political leadership to exercise control over the markets remains, according to Soros, one of the most “baffling” aspects of the ongoing crisis. The conference was designed to flesh out why. The entire agenda was predicated on the argument that we are witnessing not only an economic crisis but also a crisis in economics.
The crisis, speaker after speaker, confirmed, was the outworking of hubris, delusion, commitment to flawed ideological constructs and inattention to history. Moreover, the policy response has legitimated socialised losses on a scale unimagined by the architects of the Bretton Woods system. It has amplified the moral hazard associated with protecting a banking industry addicted to unsustainable and undesirable leverage.
Deemed too big, too interconnected and too complex to unravel without causing systemic failure, banking has emerged as the sole winner from a crisis its funding model helped to cause. Somewhat paradoxically the banking sector has become even more concentrated, making it all but impossible for regulators to control. More perniciously, the sector has a vested interest in curtailing the co-ordination necessary to engineer meaningful change, particularly in the United States but also in Europe, now the epicentre of the financial crisis.
The complexity of the deeply integrated European and North American banks demonstrates the failure of regional and global institutions of power, flawed harmonisation agendas and weaknesses of national regulation. Wariness in advocating radical restructuring risks privileging the symbolic over the substantive. As Andrew Sheng, a senior adviser to the China Banking Regulatory Commission put it, advocating piecemeal ad hoc reform overseen by a fragmented system of national regulators is “like asking pygmies to hold down giants”.
Claudio Borio of the Bank of International Settlements was more optimistic. He suggested that the Basel III process of mandating higher counter-cyclical capital buffers represented real progress. For Borio, the move towards macro-prudential regulation offered a route map for progress at both national and international levels.
As he put it “just as no individual institution is safe if the national system is unsafe so no national system is safe if the world order is unsafe”. The unmistakable message from the conference, however, is that the world is remarkably unstable, with little or no capacity to deal with inevitable future shocks.
Political attendees included the former British prime minister, Gordon Brown, and Larry Summers, the avuncular treasury secretary in the Clinton administration. Each was critical in designing a regulatory model that reinforced the dynamic towards capture. Summers remained unapologetic. Brown, speaking without notes and with passion, warned that rising national protectionism, while understandable, was dangerous.
Arguing for the need for global solutions to global problems, he contrasted the urgency and vision of the original Bretton Woods agenda with the glacial pace of progress since the current crisis began. This, he suggested, could be traced to the fragmentation of authority, the elevation of the politics of blame and the absence of an overarching normative agenda. The confluence, he argued, was not only economically counter-productive. It was also morally questionable.
In conference design, Inet was extremely sensitive to the power of ideational terms of reference. Clever video montages of turbulent seas set to The Doors classic Riders on the Stormand intercut with riots in European capitals highlighted the social consequences of the momentous changes associated with implementing the politics of austerity. This is economics with a human face. It also demonstrates a longer-term agenda.
A critical ongoing aim is to restore the reputation of the economics profession. If regulators were captured so too was the economics profession itself. As the executive director of Inet, Robert Johnson, put it in the opening address, there is a pressing need to redress the damage caused by the promotion of the “illusion of stability”. Equally, warned Dr Johnson, “warranted trust in the profession” requires practitioners to be conscious of the danger of promoting “the illusion of control”.
The recruitment into the Inet network of prominent columnists, including Martin Wolf of the Financial Times, Alan Murray from the Wall Street Journaland Anatole Kaletsy of The Times, as both contributors and moderators of individual sessions, created an alternative meta-narrative that is likely to long outlast the conference.
More significantly, the sophisticated use of social media, including a dedicated Facebook site and Twitter feeds, creates a virtual community of scholars. It also provides a platform for a viral campaign to destroy the “normal” science of economics from within. Alongside the main conference, the initiative has opened a major source of funding. Research grants to up-and-coming researchers incubate new ideas that link economics to societal purpose.
The failure of economic models to predict the global financial crisis demonstrates all to clearly the dangers of elevating elegance over substance. The result has been an inevitable decline in both influence and usefulness. Here at Bretton Woods blame for this state of affairs was placed on the structure of the discipline and the organisational pressures of the academy.
Kenneth Rogoff of Harvard captured the myopia with two anecdotes. The first centred on how a graduate student praised the professor for writing a magisterial survey of past crises and asked when he was going to return to real research. The second pointed to a much more insidious reality: academic inertia.
For Rogoff, effective study of financial crises requires interdisciplinary research. He argued that while the academy pays lip service to this, in reality organisational imperatives, linked to skewed performance indicators mandate very increasing specialisation. Harold James of Princeton suggested one way out was for the profession to conceive of its role as akin to that of a craftsman making or repairing a complex mechanical timepiece. Hinted at but not developed was the need for economics to be anchored to both real world realities and normative dimensions.
While recognition of complexity is to be welcomed, the lack of a normative dimension is disappointing. What was remarkable, however, was the continued power of self-referential terms of reference. This is neither desirable nor sustainable.
Economics requires the injection of new thinking from disciplines as varied as political science, law and ethics. The elevation of behavioural economics, a rag-tag of concepts drawn from these disciplines but not integrated within a coherent and cohesive program, demonstrates the enormity of the challenge.
There is a pressing need for new economic thinking. It cannot take place in a vacuum. For economics to save itself it must accept reintegration with the other social sciences and the humanities. It necessitates not only a return to the political economy of JM Keynes. It necessitates a return to the agenda advanced by Adam Smith, himself a professor of jurisprudence at Glasgow, which measures progress not only on efficiency but on the strength of moral communities. Contemporary economics has much to relearn.